States Face a Slow Recovery

The road to fiscal recovery for states will be bumpy, say top executives of the nation’s leading state service organizations, but they believe the slog will bring transformational changes to state governments.

The three chief executives—from The Council of State Governments, National Governors Association and National Conference of State Legislatures—offered their insights on the impact of the recession and subsequent recovery efforts during Governing magazine’s recent conference, Outlook in the States and Localities.

The outlook they shared was a bleak one for states in the short term. But they are a shade more optimistic about the long-term prospects for state budgets.

After all, said David Adkins, CSG’s executive director and CEO, “half of the Fortune 500 companies were founded during a recession or in a bear market and one-quarter of our technology firms were founded by immigrants.”

Economists agree the recession, which started in December 2007, ended in September 2009, said Ray Scheppach, executive director of NGA. But most economists believe state revenues will continue to decline another one or two quarters in 2010, Scheppach said.

“It will be 2012 or 2013 for revenues to come back to their 2008 levels,” he said, and a full recovery could take another five to 10 years. Scheppach refers to this as the “lost decade.”

As revenues continue to decline, states are facing a slow jobless recovery and increased Medicaid costs, which in this fiscal year increased between 7.5 and 8 percent. Making matters worse, Scheppach said, is that Medicaid enrollment is projected to grow 6.6 percent in the current fiscal year, compared to 5.4 percent in the 2009 fiscal year.

NCSL Executive Director Bill Pound agreed with Scheppach.

“A cliff is out there unless revenues come back,” he said.

While conventional economic wisdom says government should not increase taxes during a recession, states, facing a collective revenue shortfall of $117.3 billion, raised taxes $26 billion in the 2009 fiscal year, Pound said. The increases came primarily in broadening the sales tax base to include more services and raising income taxes on high-income earners, those making more than $250,000 a year. In the long run, said Pound, broadening the sales tax base could be a good thing for states.

But things are going to get tougher before they get better, Pound said, because the collective budget shortfall for states in the 2010 fiscal year is expected to rise to $174 billion. In 2009, states were able to offset 20 percent of their budget shortfalls with stimulus dollars, revenue that will not be there in the 2011 fiscal year.

Pound said lingering budget woes will force states to reconsider their role. “State government will be smaller,” he said, and states will ask, for example, if they should continue to run park systems.

The fundamental relationship between states and their public universities will also be questioned, especially as state contributions to universities falls below 10 percent, he said.

And Pound believes there will be a greater emphasis in state legislatures to close tax breaks.

Adkins of CSG said states’ responses to the recession are redefining federalism.

A quarter of a million federal employees write state regulations, he said. This paternalism “reduces the states’ ability to innovate.” The partisanship and polarization in Washington, D.C., narrows the field for good governance, Adkins said, pointing out that seven of 10 Senate votes are along party lines.

Feeding this gridlock, according to Adkins, are the 15,000 lobbyists in Washington who spend $420 million annually on their efforts.

The federal government recently revised its third-quarter GDP figures—for 1983. It’s the 10th revision for that quarter.

“How can we know about 2013, when we’re still revising 1983?” Adkins asked.

But Adkins is optimistic. He cited innovative state corrections policies in states such as Texas and Kansas, which worked with CSG’s Justice Center to reduce recidivism rates and lower spending for prisons.

“The choices we make today will shape our future,” Adkins said. “We freak out, and then we get over it.”